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Liquidity versus fundamentals

What on earth is going on in the US Treasury market these days…? Rates have basically turned into a flat-liner in the last 4 months. 10-year Treasury yields massively dropped amid the market havoc in March and since oscillated around the 60 basis points. Post the FOMC and Jay Powell performing yet another one of his dovish acts the yield is, in fact, drifting even lower from here, currently hovering around the 53bp handle.

Not that we should be overly surprised. The mechanism of fundamentals would have seen a degree of correlation between the S&P and the Treasury yield prevail, but haven’t we thrown overboard all belief in that. One can observe that correlation for a good 10 years to work rather formidably, ie equities and yields running pretty much in sync, up until around 2011 when the Fed started its experimentation with QE in order to paper over the credit bubble cracks.
Since then, however, we have been largely uncorrelated, to say the least. The Treasury market kept with its long-term rally seeing ever-lower rates, and the S&P embarked on the mother of all rallies, lifted by a tsunami of excess liquidity that never to its appropriate extent hit the real economy but effectively floated equity prices ever higher. Some of the pundits that still haven’t abandoned their bond bear stances have in the meantime called for a break-out of yields, for the 10-years to rebound to 1% and beyond.
It would have been the scenario of a good decade ago, but no longer. Bond yields are floored and will probably remain so for some time to come. And it’s not only Fed purchases that facilitate this. Investors are looking closely at the mayhem in the economy. Q2 growth is a disaster, not just in America but generally in the Western world by the way. Demand is now even harder to come by in the wake of the health crisis – just look at the unprecedented US savings rate of 23% currently.
This also implies there will be no inflation to come by, no matter how many monetary bubbles are being produced. With the Fed’s balance sheet hitting 7 trillion, from just over 4 only 5 months ago, and little if any of the now even bigger excess liquidity hitting the real economy, it is simply a god-sent for the stock and other financial asset markets. Against all odds, and despite all the misery in economic growth and labour markets, equities are up.
There is little that can change this trend, for now. Apart from the Trump administration escalating the conflict with China or any other serious geopolitical event, the theme should hold through the November elections. On the contrary, any stimulus measures that will inevitably emerge in coming weeks might put more oil in the stock market’s fire. Let’s watch out… the previous highs of the S&P at 3,400 might very soon be tested.
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